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Sunday, December 13, 2009

That paper on money I've been working on

Uncommon Cents:Solutions Beyond the Zero Bound

1: Defining the ProblemThe economy of the United States is currently under the greatest strain since the Depression of the 1930s. The natural boom-and-bust business cycle, combined with reckless financial speculation, the real estate bubble, and a so-called crisis of confidence has overwhelmed the safeguards of our system and put us all at risk. But is this the whole story, or is the ultimate source of the problem deeper, something fundamentally awry with the system itself? From before the founding of our nation, scarcity of money has hurt us individually and collectively by creating unemployment and poverty in the midst of abundance. There may be a way out of this recession, a way that has been proven to work, but it seems utterly nonsensical and a violation of the accepted conventional wisdom.

This perception is in part because the average person finds economics and monetary theory intimidating and overcomplex. In a recent New York Times article, N. Gregory Mankiw states, "Recessions result from an insufficient demand for goods and services". This is true, but ignores a basic assumption. In today's recession, as in past economic panics and crashes, the problem is not that people don't want or need available goods and services, it's a lack of money – goods and services are in oversupply, and no one has the resources to buy them. The net effect of this is people being thrown out of their homes because there are too many unsold houses. The counterintuitiveness of this clearly shows that it's time to take a different approach to the problem, an approach that begins by seeing money for what it really is and reimagining money in a way that adds fluidity and utility to currency. During past economic troubles, communities have successfully introduced and used local, negative interest currencies to create sustainable economic conditions, islands of prosperity in the sea of economic depression. This alternate form of money, when properly designed, avoids some of the systemic flaws that are currently disrupting civilization.

2: Background – The Nature of MoneyBefore attempting to solve the problems of the money supply, money itself needs to be understood. What is money? Although money and wealth are frequently conflated, the most common economic definition is as medium of exchange. According to fin de siècle economic thinkers Hugo Bilgram and Louis Edward Levy, money is "a consensus of the members of the community to accept certain valuable things, such as coin and certain forms of credit, as mediums of exchange" (qtd. in Greco Money 25). Nietzsche describes money as "the crowbar of power" (qtd in Greco End 10). Many modern economists and economic thinkers define our current monetary system as debt, because of the way new money comes into circulation. In 1969, in a controversial legal case in Scott County, MN, a bank president states on record, in reference to a $14,000 mortgage, that "the money and credit first came into existance[sic] when they created it" (First National Bank of Montgomery vs. Jerome Daly). According to Modern Money Mechanics, a pamphlet by economist Anne Marie L Gonczy published until 1992{1} by the Federal Reserve Bank of Chicago, The actual process of money creation takes place primarily in banks....checkable liabilities of banks are money. These liabilities are customers' accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers' accounts (3).

Community economist Thomas H. Greco Jr analyses this paragraph to describe how banks create the vast majority of money simply by depositing it into customer's accounts. He addresses the role of customer deposits by stating these deposits represent money created in the form of a loan to some person, business, or governmental entity who you then recieved it from (Money 5-7).

International money expert Bernard Lietaer, one of the creators of the Euro, goes one step further and presents the parable of "The Eleventh Round" to explain how this leads to the corrosive effects of positive interest. In his parable, a community with a barter-based economy is introduced to currency (by an outsider, in the form of loans) as a means of simplifying market transactions – a medium of exchange in the form of a stamped, round piece of leather. Each of the eleven families in the village is issued ten of these leather coins, valued at one chicken each, under the condition they pay the outsider eleven leather coins one year later. In order to do this, the villagers were forced to compete for coins, rather than cooperate as they always had. The introduction of interest-bearing currency required either one or more families lose coins, or the economy had to grow enough to allow the villagers to borrow enough to pay the interest with further loans. This, Lietaer asserts, is the elephant in the living room of the current monetary system – "When the bank creates money...it only creates the principal....when you pay back interest on your loan, you are using someone else's principal" (Lietaer Future 50-54). The monetary system in use today inevitably creates winners and losers and requires constant, uninterrupted growth for its survival. As long as we depend exclusively on this system, we are locked into the Red Queen's Race, where we have to run as hard as we can to merely stay in the same place, a paradigm of perpetual growth in which stability is economic disaster.

The key to the flaw in this system is positive interest. When banks create money, they charge the borrower for the use of this money. There is no economic advantage to anyone in this system save to the bank. In the absence of interest, the debt basis of money does little if any systemic damage: when money carries negative interest, it flows through the economy rather than concentrating wealth in the hands of the few. The creation of money from nothing at all is not a problem in and of itself provided the money created represents value rather than debt, provided it stabilizes or increases rather than decreases the money supply. The debt-based money in use today decreases the effective money supply simply because, according to Greco, "the available supply of money...is never sufficient to enable all debtors to pay what they owe"(End 55).

3: Thoughts on Rational CurrencyIn 1729, Ben Franklin published a broadside about the utility of paper money. He understood that the scarcity of money "discourages Laboring and Handicrafts Men" and devalues domestic production, including land (Modest). He advocated the issue of a paper scrip without inherent interest, but did not go so far as to speculate about negative interest, saying merely that "A plentiful Currency will occasion Interest to be low..."(Modest). Economist Irving Fisher describes the next great leap in the theory of currency in his 1933 pamphlet "Stamp Scrip", named for the negative interest currency developed by German economic thinker Silvia Gesell and put into use in Germany during the post-WWI depression (Ch. 4). The key to stamp scrip is that it rewards circulation and punishes hoarding. Fisher describes a theoretical municipal scrip. He begins with the premise that a town issues $1000 in paper specie with two conditions: the town will redeem each $1 of scrip for $1 in legal tender at the end of one year from the issue date and, each Wednesday, each bill must have a stamp affixed, costing $0.02 and purchasable from the city.

The town issues this scrip by spending it – in Fisher's example, the town uses it to hire workers for a new municipal job. The third requirement for this stamp scrip to work is that it be accepted by both the workers and a critical number of town businesses, allowing it to circulate. Although there is no ordinance requiring scrip to be accepted, normal market forces will lead to near-universal acceptance, for if Shop A accepts scrip and Shop B doesn't, Shop A will have more sales and Shop B will lose business. At the end of the year, the city has sold $1040 worth of 2-cent stamps, and can easily redeem the scrip for federally-recognized money (Ch. 3). In Germany, a stamp scrip based on Gesell's work called wära (with a 1%/month stamp) in circulation since 1919 with limited acceptance and utility became, in 1931, the prime currency in the village of Schwanenkirchen. Fisher's associate Hans Cohrssen describes the experiment in an article in The New Republic, extensively excerpted by Fisher. The owner of a closed local coal mine reopened the mine by paying his workers in wära. The local businesses accepted wära because it was, at the time, the only game in town – Germany as a whole was in a cataclysmic depression – and the money circulated from workers to vendors to their vendors to creditors and, in many cases, back to the mine where it was taken in payment for coal. In the case of Schwanenkirchen, the original funding of the wära was a 40,000 mark loan taken by the mine owner. If he had paid the workers directly with these borrowed marks, the mine would have been rapidly closed and the town returned to its dire economic straits because the marks would have been hoarded rather than circulated. The wära, losing value on a predetermined schedule, circulated rapidly as no one wanted to be the person who had to buy the next monthly stamp (Qtd in Fisher Ch. 4).

Fisher then continues by discussing how the use of wära with this sort of full community support sparked an economic renaissance in this village of 500 and was beginning to spread beyond the borders as businesses and banks nationwide began to accept wära. The experiment ended because the German government, after failing to prove in court that the wära was an illegal currency, legislated it out of existence, destroying the burgeoning local economy of Schwanenkirchen (Ch. 4). Senior Federal Reserve research economist Bruce Champ discusses how a similar plan was implemented in the Austrian city of Wörgl (pop. 4300) in 1932 with some success until, like wära in Germany, the alternative currency was shut down by the government (2-3). In the case of the currency used in Wörgl, it was not tied to the legal tender of Austria, rather, it was simply issued (by spending) and accepted as payment by the city (Stamp Ch. 4).Fisher describes several stamp scrip experiments in the U.S. in 1932, ranging from $300 issued in the 2000-person city of Russell, Kansas to a plan by the city of St. Paul to issue $100,000 in municipal scrip as soon as authorized by the state legislature (Ch. 5). These scrip plans differed between locations and had varying degrees of success, but none became permanent. Champ states that they all failed, in the long run: many communities used scrip that was stamped at transfer rather than on a schedule, in effect discouraging exchange; and when the overall economic picture improved, the additional work involved in use of stamp scrip made the use of conventional currency more attractive (3-4). In the case of Schwanenkirchen and Wörgl, however, the currencies did not fail – they were shut down by the government. The reasons for this vary by the worldview of the ones doing the explaining; alternate currencies are fertile ground for conspiracy theory. {2}

Given that the current monetary system consists of bank debt and money is, by that definition, always in short supply, how can an alternative currency help? The examples of Schwanenkirchen and Wörgl prove that the proper use of negative interest currency can amoreliate economic troubles on a local level. One of the problems of a strictly local currency is the need to have another currency for use on a larger stage – one cannot expect the federal government, for example, to accept tax payments in CloudBux. Currently, the government taxes barter and exchange systems by valuing the currency of use in dollars, requiring people using those systems to have a source of legal tender (IRS.gov).

There is no reason the government cannot issue currency, rather than giving credit to banks in the form of bonds and then borrowing against that credit as is now done through the Federal Reserve System. The paper currency Ben Franklin lauds is directly issued by the government. According to Gonczy's Modern Money Management, money is "A tool used to facilitate transactions...readily accepted in exchange for goods, services, and other assets...."(1). Therefore, money, in the modern conception, is not a physical object that can be exchanged 1:1 for a valued commodity, as all money once was{3}. Any entity can create money, provided someone else accepts it as such. In practical terms, this means it must either be directly accepted by the government or easily convertible into acceptable currency.

At this time, one of the stumbling blocks of alternative currency is that it is not accepted by the government, and is actively discouraged today just as the Wörgl scrip and the wära were in pre-WWII Europe. Ellen Brown, a lawyer and currency reform advocate, describes the rise and fall of a 21st century alternative currency in America. An organization began issuing a commodity-based currency called the Liberty Dollar, which was redeemable for gold or silver held in a private facility (in order to assure its acceptance). In 2006, the equivalent of $20,000,000 was circulating in Liberty Dollars. In November 2007, the assets of the organization were seized by the FBI on the grounds that the organization was counterfeiting, even though Liberty Dollars were not duplications of U.S. currency. A spokesman for the government stated, "The United States Mint is the only entity that can produce coins" (339-340).

4:A Model for SurvivalHow can a negative-interest currency be implemented in a way that helps solve the economic problems of the nation as a whole? One of the weaknesses of any national currency is that it can be devalued by external influences. Brown mentions the British practice in the 1770s of wholesale counterfeiting of Franklin's paper currency, the Continental, and alludes to international speculation in national currencies including the practice of short-selling to devalue currencies in modern times(43).

The optimal currency for a nation would be accepted for payment of civic debts, would be directly issued (spent into being) by the government, and would not come into being with interest due. This would increase, rather than decrease the money supply. There is an example in American history of a zero-interest national currency. Brown relates how during the Civil War, President Lincoln had $400,000,000 printed in the form of United States Notes, which were "receipts acknowledging work done or goods delivered" and were used for federal wages and to purchase war materials(83). This paper money was distinguished by the use of green ink on the back – the Greenback{4}. This extra money, created out of nothing but the agreement by the government to accept it at face value, financed the war and stabilized the economy while avoiding the debt burden of bank-issued currency.

In the information age, it is no longer necessary to have physical specie. A national issue of negative-interest currency would increase the money supply without increasing our collective debt. Although there would be benefit from a new issue of Greenbacks, combining this with the attributes of negative interest would allow us to pull ourselves out of this crisis by our own financial bootstraps. Since negative-interest currency devalues on a regular schedule, it will not be hoarded – it is designed to be a medium of exchange, not a medium of savings. This devaluation was historically accomplished by purchase of a stamp, but with a primarily electronic currency most of the "stamping" can be done by pushing a few electrons, the same way that most debt money is created today. American Enterprise Institute Fellow Alex Pollock hints at how this mechanism could work by comparing it to ATM fees, stating how a $2.00 ATM non-customer surcharge on a $100 withdrawal is effectively -2% interest.Scarcity of money is the direct cause of countless human miseries. Having the right amount of money available, and that money circulating freely, is the definition of a viable economy. The current system of privately issued debt money is no longer serving the interests of the people – if it ever did. A national, government issued negative interest currency would not only solve the current crisis by fully funding the economy, but might lead to a new Renaissance. There are few societal problems today that are not in one way or another related to the scarcity of money – solving this scarcity leads the way to abundance on all levels.

{Notes}1 Brown speculates that the Federal Reserve stopped printing Modern Money Mechanics in 1992 because it "revealed too much". (169) It has been cited in multiple court cases, and remains available online.2 My first exposure to alternative currency was in the Illuminatus! trilogy by philosopher Robert Anton Wilson, an 800 page farce on the theme of conspiracy as truth and the 20th century as a struggle between secret societies for control of the world. One of the groups finances itself with flaxscrip, a zero-interest currency, and another with hempscrip, which is Fisher's stamp scrip with a counterculture twist.3 See Greco's "Money" for a thorough description and history of commodity money and the evolution of the idea of money that leads from barter to Collateralized Debt Obligations, and beyond.4 I was born and raised within a few miles of Greenback Lane, a major thoroughfare in the Sacramento area that runs from Folsom (fabled in story and song) to Rio Linda (at one time home to Lee Greenwood and Rush Limbaugh, among others). It was laid in 1864 and given its name because the original landowner was paid in United States Notes, over his protests that Lincoln's Greenbacks were not "real money" – but he eventually accepted them for payment, and there is no record of his having any problem spending them in turn.